GILTI Tax and Transition Tax on Foreign Business Income Explained

Let’s pretend it is 2017 again (yes, we know it’s 2020). Congress has just passed The Tax Cuts and Jobs Act (TCJA). making several significant changes to the individualized income tax on foreign businesses. As an American with interests overseas, how does this affect you? How will you handle it in the future?

The TCJA looks to cut corporate, individual, and estate tax rates as one of the areas impacted is foreign tax credits. In prior years, U.S. residents had been able to postpone taxation by holding profits via a foreign entity. As a bulk shareholder, you were only required to pay out taxes upon the delivery of funds. With the TCJA came the Transition Tax, a one-time tax authorized by the IRS to transfer to the new GILTI tax. In other words, the IRS wants to tax the revenues of foreign companies owned by American people, and this is how they do it.

As with any tax law, understanding this new tax can seem difficult and complex. We have information from Leo, a seasoned tax director from Expat U.S. Tax. He supplied us with valuable knowledge for Americans who own businesses overseas.

GILTI Tax Explained

GILTI Tax, ‘Global Intangible Taxed Income,’ correlates to United States shareholders of controlled foreign corporations, ‘CFCs’ for short. A US proprietor of a CFC is obliged to account for and pay U.S. federal taxes on their portion of a CFC’s non-previously taxed and undistributed earnings each year. Going forward, the owner will need to determine their profits and pay what frequently described to as GILTI Tax. 

Transition Tax Breakdown

Before you move forward with the GILTI tax, you need to take care of the Transition Tax, also known as Section 965.  It requires United States shareholders to compensate a mandatory, one-time transition tax on the untaxed foreign profits of certain specified worldwide corporations, as if those revenues had been taken back to the US. 

How does this have an effect on shareholders of a company like myself?

It can be difficult to pay for when you haven’t received financial reimbursement. Companies can be subject to tax where that company is established, which causes a double tax.   People often end up reorganizing their business to avoid paying the double tax. There are other answers, though. One solution is to make sure that the United States owner does not have a controlling interest in the corporation as a whole. If a person owned 100% of a company and they were a United States citizen, this would subject them to GILTI. This being said, they might weigh their options to minimize their shares or find a way where they do not own the controlling interest of that company. If this person decreased their shareholding down to 50%, they would not be subject to GILTI Tax as long as the other shareholder(s) weren’t US residents. This business owner would still have a 5471 reporting obligation to the IRS, as they still own of 50% of a non-US business. Nevertheless, the GILTI tax would be applicable in this situation.

Should I worry about GILTI Tax?

Many individuals oppose the concept of paying tax on earnings they have yet to receive into their possession. The general assumption in the tax world, is that you would want to collect the funds first, then reimburse the tax. In this case though, assets are still sitting in the business, and you haven’t gotten those yet. Therefore, you don’t have the currency flow to pay the tax on the earnings yet. This creates a tax responsibility and causes a cash shortage for individuals.

Let’s look at Section 962

This is a yearly election one can make when they file the data return for a company. It is an accessory to the 5471 foreign corporation return that is then attached to an individual’s 1040 personal tax return. One advantage of this option is that it allows you a lowered business tax rate of 21%, although the personal tax rate is usually 37%. The election is something a individual would define on a year-by-year basis.  The primary use of Section 962 is to attain the advantage of the lower business tax rate. Specific deductions are accessible from the corporate aspect that is available through this election, and can bring tax on foreign company profits down to 10-13% and furthermore become a tax credit. If the foreign corporation turns a profit and is subjected to tax, the tax is paid by the corporation and can be deemed as an improbable foreign tax credit for someone who elected this. There can be cases in the home nation where the tax rate is higher than 21%, and other occurrences in which you get full offset of foreign tax credit and you don’t pay taxes on profits at that time. The problem is that there is a likelihood that a forthcoming tax issue could happen. If once that election is chosen, and you have a distribution of revenue later in the form of a dividend, these dividends would be subjected to United States tax later on that year.

What if I haven’t filed GILTI yet?

We questioned Leo about patrons who filed their standard 5471 forms and their understanding of GILTI. Regrettably, some people do not know what GILTI Tax is or may presume it does not apply to them for multiple reasons (they are self-employed or the business they own is small). When put in this situation, many owners believe they can bypass the fees by merely amending their tax returns. Leo informs us that this will cause more damage than good. If the IRS finds out you avoided taxes and fees, more difficulties and costs will arise. Greater interest rates, penalties, and more severe dilemmas could result. Avoid these consequences by taking care of it right at the start. There are other ways to lessen your obligations to the IRS, and Expat US Tax knows all the ins and outs. With our knowledge, we can help you catch up on U.S. taxes or advise you about your GILTI and Transition Tax options and obligations.

What should I do if I need an expert’s advice or guidance?

We recommend learning as much as possible about your present position, but also when working with someone, you should create a plan for the future. Developing a strategy after paying off your past debts will ensure that you stay current, eliminate all penalties, and help avoid having to file amendments for inaccuracies. Not all circumstances are the same; actually, none of them are. When you work with a licensed pro, you will have several options that give you the ability to decide what suits your particular requirements. At Expat US Tax, they are ready to assist you with any questions or concerns you may have. Contact them today!

Calculate your tax now.

Timing issues and the question of which tax rate is more beneficial can arise. The answer is to calculate this each year to see whether it is tax advantageous to elect Section 962 or not. It will vary based on a few different things: 

  • Corporate tax rates
  • Foreign taxes paid out
  • Total net profit
  • Corporate deductions
  • Other modified factors

There may be other situations where the foreign tax credit isn’t eligible. If a local country does not enforce corporate tax on a business, there would be no foreign tax credit. If one owner has a CFC and holds net profit even if one makes the election, they must anticipate a minimum of a tax at least 10-13% for that net profit. However, that person will still have that dilemma of how to get distributions out of that company and what tax will transpire later when that distribution follows. That’s where a solution of changing the U.S. citizen shareholder ownership to no more than 50% can be helpful.

It is possible to pay the taxes in the form of a salary or bonus. Tax experts advise international business owners to be proactive in determining whether or not they are entitled to GILTI rules, and to estimate their tax obligation in advance and plan appropriately.